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Friday, June 05, 2009

The worst of both worlds

It seems like Germany has broken with the principle of independent central banking, apparently fed up by the policies of the European Central Bank. The Financial Times reports that German Chancellor Angela Merkel yesterday criticised the world's main central banks in surprisingly strong terms, suggesting that their unconventional monetary policies could aggravate rather than ease the economic crisis. Merkel told a conference in Berlin: "What other central banks have been doing must be reversed. I am very sceptical about the extent of the Fed's actions and the way the Bank of England has carved its own little line in Europe.” She added that “even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds," and concluded saying: "we must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years' time."

The very important decision by the ECB to cut interest rates to a record low of 1 percent, and to embrace "quantitative easing" for the first time was taken some weeks ago. As The Telegraph reported, the latter meant buying 60 billion euros of covered bonds in an attempt to kick-start the economy, as the lever of lowering interest rates is all but exhausted. The FT now writes that it is likely that Germany will have to account for about 25 percent of the 60 billion euro stimulus.

In the meantime, another announcement was made that will allow the European Investment Bank, the EUs long-term lending bank, to gain access to ECB funding by taking part in the central bank's money market operations. It seems like there is no end of measures that are likely to prey on German sensitivities.

Germany, and its Bundesbank chief Axel Weber, has always opposed these kind of actions, fighting “a rearguard battle to head off Quantitative Easing, calling it an 'undesirable option' that risked inflation later", as Ambrose Evans-Pritchard notes. He adds that the ECB's decision to fund more monetary stimulus signifies a defeat for the Bundesbank in a very important battle against national governors from southern Europe and Ireland and "touches on a raw nerve in Germany where critics have always suspected that EMU would turn 'soft'" and that "it may set off a political backlash."

Indeed it now has. After ECB board member Marko Kranjec said that the covered bond purchase program would "very likely" cost more than the initial figure of 60 billion euro and that the ECB will even consider asset purchases beyond (the very safe) covered bonds, German Bundesbank President Axel Weber was forced to counter him, openly opposing “further monetary and budgetary expansion in the middle and long term”. And now a German Chancellor has waded into the debate, rejecting the ECB's policies without leaving any doubt, ironically violating the 'sacred' German principle of central bank independence. While the Wall Street Journalsupports Merkel's criticism, Jean-Claude Trichet and Ben Bernanke have defended themselves.

Whether the course the ECB has taken will reach its goal is debated among economists, with some warning of hyperinflation as a result of its actions.

So what do we have now? Germany dissatisfied with ECB policy, as it confronts the reality that the German tradition of "hard money" is not shared with the same vigour throughout the EU and that the Bundesbank's influence on the ECB is not what it once was.

Germany's rebuke to the ECB is closely linked to the German government's stance towards the idea of common issuance of European sovereign debt, which would in effect see Germany as guarantor in chief to the eurozone. Despite earlier claims by the German government that it would bail out struggling eurozone states, such as Ireland, the German ruling classes are wary of being locked into guaranteeing other member states.

However, in the Times Anatole Kaletsky has argued that the EU's 'balance of payments facility', recently doubled to 50bn euros and underwritten by the EU budget, is evidence that the German government is being less than honest to its people about the true extent to which Germany is already guaranteeing the debts of struggling member states, describing it as Europe's 'secret bailout' and a 'perversion' of democracy.

Germany is treading a fine line between holding the eurozone together and telling the German people some uncomfortable truths about the responsibilities that were implicit when EMU was first launched. As Derek Scott, vice-Chairman of Open Europe and former Economic Advisor to Tony Blair, said in our EMU debate: "it seems to me that Mr. Delors was probably right, saying that this thing cannot exist without having a political union".

Whether or not citizens feel they belong to one European political union and demos, is clear. They don't.

At least now politicians are finding it harder to disguise the reality: monetary union is unsustainable in the long term without political and fiscal union.

The Bundesbank's loss of influence over the ECB, which steadily seems to be slipping out of Germany's hands, has got to the point that a German Chancellor is prepared to give up the sacrosanct German principle of the central bank's independence. It serves to illustrate the wider point that Germany is no longer in charge of its economic destiny and, at the same time, is increasingly responsible for the fate of others'.

Maybe, in the end, it will not be a weak periphery economy such as Greece that leaves the eurozone, but rather a Germany, whose population refuses to bear the responsibilities that monetary union inevitably brings.